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Reversing sentiment for Brazil and Argentina

Argentina’s stunning return to the international debt markets in April has resulted in a surge of positive sentiment for the country in stark contrast to neighbour and rival Brazil, a husk of its former self due to fraught politics and a deteriorating economic outlook.

Buenos Aires is crying tears of joy after clinching a $16.5 billion dollar bond that generated around $70 billion in orders and ended its 15 years of exile since its 2001 default. The issue has sparked hopes that hard-currency borrowing costs for provincial governments and Argentine companies will fall and that the investment will revive the country’s stagnant economy.

Brasilia, meanwhile, is going in the opposite direction. The International Monetary Fund predicts a fall in GDP for 2016 similar to last year’s 3.8% contraction. The Fund also anticipates debt-to-GDP will hit 91.7% over the next five years, after spending much of the last decade in the low-to-mid 60% area.

Brazil will find it harder to service its debt as the GDP to debt ratio increases. Local currency 10-year government bonds are currently yielding less than 13%, but have been as high as 16.74% this year. The Brazilian government issued a 10-year US dollar bond in March, at a 6% coupon, which quickly widened to 6.429%. The paper had rallied to 5.67% on 26 April but it is debatable whether this level equates to value for investors given the long-term outlook for Brazil’s credit metrics as well as the less appealing valuation when compared to local currency debt.

Political strategy is at the root of where it all went wrong for Brazil and started to go right for Argentina.

Brazil’s lower house on April 17 voted this week to start impeachment proceedings against president Dilma Rousseff, leaving her political future in the balance amid claims that her policies are largely responsible for squandering the country’s previous and hard-won success. The impeachment process will take at least six months and opens the already fragile Brazilian economy to more uncertainty. Investors are wary with a lack of forward visibility on what the Brazilian government might look like at the conclusion, or what its policies might be.

It’s all a far cry from 2009, when the commodities boom maintained Brazil’s effervescence as developed markets were collapsing. Then president Luiz Inacio Lula da Silva, Rousseff’s mentor, hailed discovery of the country’s largest oil reserves as “a passport to the future”. News that same year that Brazil would host the 2014 World Cup and the 2016 Olympics increased confidence and was interpreted by many Brazilians as proof of their country’s growing international standing.

By 2013 Brazil’s star status was waning. Critics said Rousseff’s policies – a hark back to 1950s developmentalism – had created an inflated public bureaucracy, huge job losses and soaring interest rates. The slump in demand for Brazilian commodities like iron ore was also hurting the country and the brewing scandal at national oil giant Petrobras was eroding the administration’s political credibility.

Argentina, on the other hand, has laid promising foundations for further ratings upgrades on completion of the new bond and a preceding settlement with holdout creditors from the 2001 debt restructuring. Since its election in December, Mauricio Macri’s Lets Change (Cambiemos) coalition has lifted capital controls and allowed the peso to float more freely, reduced energy and transportation subsidies and has started to deal with longstanding macroeconomic imbalances.

Moody’s on April 15 upgraded Argentina’s issuer rating to B3 with a stable outlook. Investors recalibrating their view on the country should not underestimate the potential for a rise to BB or equivalent in the next two years based on the speed and success of these early reforms. If the positive reform momentum continues, Argentina could be on course for a return to the investment grade universe over the longer-term.

That trajectory would give Argentina a larger slice of the finite capital flowing into Latin America, creating more competition for Brazil and greater pressure to reverse current weakness. While not an economic indicator, Argentina’s second place in the 2014 World Cup compared to Brazil’s fourth ranking is striking symbolic illustration of the shifting perceptions of the two countries.

Argentina aficionados should not get carried away, however.

Latin America’s third largest economy is riding high on sentiment and its new administration has established early credibility for its reform agenda. Yet, Argentina has defaulted on its debt eight times since 2001 and formidable challenges remain for the economy, especially the high fiscal deficit and inflation.

Most tellingly, the biggest remaining challenge lies ahead in convincing the market that Argentina’s new administration can produce trustworthy numbers. In February 2013, it became the first country to be censured by the IMF for failing to provide accurate inflation data. Three year later, the Fund said Argentina had failed to take sufficient steps to improve the quality of economic statistics in line with global standards. Those castigations happened on the watch of the previous government led by Cristina Fernandez de Kirchner, but as is often said in finance, one swallow – in this case Macri’s early and decisive action – does not make a summer.

Important Information

Except where stated otherwise, any sources of all information is Aviva Investors Global Services Limited “Aviva Investors” as at 28thApril 2016. Unless stated otherwise any views and opinions expressed are those of the author and should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Aviva Investors Global Services Limited, registered in England No. 1151805. Registered Office: St. Helen’s, 1 Undershaft, London EC3P 3DQ. Authorised and regulated in the UK by the Financial Conduct Authority and a member of the Investment Association.

Aaron Grehan

Aaron joined the investment industry and Aviva Investors in March 2000. He was previously a credit fund manager in the liability driven fixed income team managing portfolios for institutional clients.

Experience and qualifications

Aaron joined the credit team in 2004 as a portfolio analyst before becoming an investment analyst in both the LDI FI and Credit teams. Aaron is a CFA® charterholder and holds the investment management certificate.